SEC v. Harbinger Capital Partners LLC, OIP 34-67279

The Securities and Exchange Commission today filed fraud charges against New York-based hedge fund adviser Philip A. Falcone and his advisory firm, Harbinger Capital Partners LLC, for illicit conduct that included misappropriation of client assets, market manipulation, and betraying clients. The SEC also charged Peter A. Jenson, Harbinger’s former Chief Operating Officer, for aiding and abetting the misappropriation scheme. Additionally, the SEC reached a settlement with Harbinger for unlawful trading.

In a separate settled action, the SEC charged Harbert Management Corporation, whose affiliates served as the managing members of two Harbinger-related entities, as a controlling person in the market manipulation.

The SEC alleges that Falcone used fund assets to pay his taxes, conducted an illegal “short squeeze” to manipulate bond prices, secretly favored certain customers at the expense of others, and that Harbinger unlawfully bought equity securities in a public offering, after having sold short the same security during a restricted period.

The SEC filed actions in U.S. District Court for the Southern District of New York against Falcone, Jenson, and Harbinger, and, in connection with the illegal trading scheme, separately instituted and settled administrative and cease-and-desist proceedings against Harbinger.

In particular, the SEC alleges that:

Falcone fraudulently obtained $113.2 million from a hedge fund that he advised and misappropriated the proceeds to pay his personal taxes;

Falcone and two Harbinger investment managers through which Falcone operated manipulated the price and availability of a series of distressed high-yield bonds by engaging in an illegal “short squeeze;”

Falcone and Harbinger secretly offered and granted favorable redemption and liquidity rights to certain strategically-important investors in exchange for those investors’ consent to restrict redemption rights of other fund investors, and concealed the arrangement from the fund’s directors and investors; and

Harbinger engaged in illegal trades in connection with the purchase of common stock in three public offerings after having sold the same securities short during a restricted period.

Misappropriation Scheme

In the misappropriation scheme, the SEC alleges that Falcone unlawfully used fund assets to pay his personal taxes. In 2009 Falcone owed federal and state authorities $113.2 million in taxes. Declining to pursue other financing options, such as pledging his personal assets as collateral for a bank loan, Falcone elected instead to take a $113.2 million loan from the Harbinger Capital Partners Special Situations Fund, L.P. – the same fund from which Harbinger had earlier suspended investors from redeeming.

Falcone authorized the transfer of fund assets to himself in a transaction that Jenson helped structure. Falcone and Harbinger never sought or obtained the consent of its investors prior to using the fund's assets to benefit Falcone.

As part of the misappropriation scheme, the SEC alleges that Falcone and Harbinger, aided by Jenson, made several material misrepresentations and omissions in seeking legal advice regarding the loan and in subsequent communications with investors, including, among other things:

the financing alternatives available to Falcone;

the circumstances that led to Falcone’s need for the loan;

the ability of the Special Situations Fund to furnish the loan, without disadvantaging investors;

the terms and conditions of the loan, including the interest rate charged and the amount of collateral posted by Falcone; and

the role of Harbinger’s outside legal counsel in vetting the transaction.

The SEC also alleges that Falcone and Harbinger delayed disclosing the loan for approximately five months because of their concern that disclosure of Falcone’s financial condition might have a negative impact on investor withdrawals and on Falcone’s ability to attract more investments for other Harbinger funds. Falcone repaid the loan in 2011, after the Commission commenced its investigation.

Market Manipulation / Illegal Short Squeeze

In a separate civil action, the SEC alleges that from 2006 through early 2008 Falcone and two Harbinger investment management entities manipulated the market in a series of distressed high-yield bonds issued by MAAX Holdings Inc. In this fraudulent scheme, Falcone and the Harbinger entities allegedly orchestrated an illegal “short squeeze” – a market manipulation scheme in which an investor constricts the supply of a security, through large purchases or other means, with the intent of forcing settlement from short sellers at arbitrary and inflated prices.

The SEC’s complaint alleges that at Falcone’s direction, Harbinger purchased a large position in the MAAX bonds during April and June of 2006. After hearing rumors that a Wall Street financial services firm was shorting the MAAX bonds and also encouraging its customers to do the same, Falcone decided to seek revenge. In September 2006, Falcone directed the Harbinger-managed funds to buy every available bond in the market, often purchasing the bonds from short sellers. Ultimately, Falcone raised the funds’ stake to approximately 13 percent more than the available supply of the MAAX bonds.

At one point, Harbinger had purchased 22 million more bonds than MAAX had ever issued. Contemporaneously with these purchases, Falcone locked up the MAAX bonds the Harbinger funds had purchased in a custodial account at a bank in Georgia to prevent his brokers from lending out the bonds to sellers seeking to deliver the bonds to purchasers after short sales.

Having seized control of the supply of the MAAX bonds, Falcone then demanded that the Wall Street firm and its customers settle their outstanding MAAX short sales, not disclosing that it would be virtually impossible to find bonds available for delivery. The Wall Street firm bid daily for the bonds, which quickly doubled in price. Then, Falcone engaged in a series of transactions with certain short sellers at arbitrary, inflated prices, while at the same time valuing the funds’ holdings on his books at a small fraction of the prices he charged the covering short sellers.

Preferential Redemption Scheme

In its action alleging misappropriation, the SEC also alleges that, in a further breach of Falcone and Harbinger’s fiduciary duties to their clients, Falcone and Harbinger engaged in unlawful preferential redemptions for the benefit of certain favored investors.

In 2009, while soliciting required investor approval to restrict withdrawals from another Harbinger fund, Falcone and Harbinger secretly exempted certain large investors that Falcone deemed to be strategically important from soon-to-be imposed liquidity restrictions – provided those investors voted to approve restrictions that would temporarily stabilize the decline in Harbinger’s assets under management.

Ultimately, pursuant to these ‘vote buying’ agreements, Falcone and Harbinger allegedly permitted these investors who were connected to certain favored institutional investors to withdraw a total of approximately $169 million. Harbinger concealed these quid pro quo arrangements from the independent directors and from fund investors.

Other Illegal Trading by Harbinger

In a separate administrative and cease-and-desist proceeding, the SEC found that between April and June 2009, Harbinger violated Rule 105 of Regulation M of the Securities Exchange Act of 1934 (Exchange Act). Rule 105 is an anti-manipulation rule that prohibits short selling securities during a restricted period and then purchasing the same securities in a public offering.

The Commission’s Order censures Harbinger and requires the firm to cease and desist from committing or causing any violations of Rule 105 now or in the future. Harbinger will pay disgorgement in the amount of $857,950, prejudgment interest in the amount of $91,838, and a civil monetary penalty in the amount of $428,975. Harbinger consented to the issuance of the Order without admitting or denying any of the Commission’s findings.

Settlement with Harbert Management Company

In a separate complaint also filed in U.S. District Court for the Southern District of New York, the SEC filed a settled civil action against Harbert and two related investment entities – HMC-New York Inc. and HMC Investors, LLC – for their role in the illegal short squeeze described above.

The SEC alleges in its complaint against Harbert that during the entire period of the short squeeze, Defendants Harbert, HMC-NY and HMC Investors, directly or indirectly, possessed the power to control Falcone and the investment managers through which he operated. Defendants HMC-NY and HMC Investors, two entities controlled by Harbert, served as the managing members of two limited liability companies that acted as the general partners of the funds advised by Falcone.

Harbert and its affiliates also provided hedge fund administration, legal, compliance, risk assessment and other services to the funds. In these capacities, Harbert, HMC-NY and HMC Investors knew of Falcone’s trades in the MAAX bonds, but failed to take appropriate steps to address Falcone’s manipulative conduct. The SEC charged the Harbert defendants as controlling persons pursuant to Section 20(a) of the Exchange Act, alleging that they are jointly and severally liable for Falcone’s and the Harbinger investment managers’ violations of the antifraud provisions of the Exchange Act.

Without admitting or denying the allegations of the complaint, Defendants Harbert, HMC-NY and HMC Investors have agreed to pay a civil penalty in the amount of $1 million. The Harbert defendants also have consented to the entry of a judgment enjoining them from violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The proposed settlement with Harbert is subject to approval by the court.

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The SEC’s complaint relating to the misappropriation and preferential redemption action, which was filed in the United States District Court for the Southern District of NY (USDC for the SDNY), charges Falcone and Harbinger with violations of Section 17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act of 1933 (Securities Act); Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rules 10b-5(a), 10b-5(b), and 10b-5(c) thereunder; and Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 (Advisers Act) and Rule 206(4)-8 thereunder. Falcone is further charged with a violation of Section 20(a) of the Exchange Act as a control person of Harbinger, and the complaint alleges he is therefore jointly and severally liable for Harbinger’s violations of Section 10(b) of the Exchange Act and Rules 10b-5(a), 10b-5(b), and 10b-5(c) thereunder. As to Jenson, the SEC’c complaint alleges that he aided and abetted Falcone’s and Harbinger’s violations of Section 10(b) of the Exchange Act and Rules 10b-5(a) and 10b-5(c) thereunder and Falcone’s and Harbinger’s violations of Sections 206(1), 206(2) and 206(4) of Advisers Act and Rule 206(4)-8 thereunder. In its complaint, the SEC seeks permanent injunctive relief against each defendant to enjoin them from future violations of the federal securities laws, disgorgement of ill-gotten gains, financial penalties and an order barring Falcone from serving as an officer or director of a public company.

The SEC’s complaint relating to the short squeeze, also filed in the USDC for the SDNY, separately charges Falcone and the Harbinger entities with violations of Section 17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act and Section 10(b) of the Exchange Act and Rules 10b-5(a), 10b-5(b), and 10b-5(c) thereunder. In that action, the SEC also seeks permanent injunctive relief against each defendant to enjoin them from future violations of the federal securities laws, disgorgement of ill-gotten gains, and financial penalties.

The SEC’s complaint against the Harbert defendants charges them with a violation of Section 20(a) of the Exchange Act as control persons of Falcone and the Harbinger entities, and the complaint alleges they are jointly and severally liable for Falcone’s and the Harbinger entities’ violations of Section 10(b) of the Exchange Act and Rules 10b-5(a), 10b-5(b), and 10b-5(c) thereunder. The Harbert defendants consented to the entry of a permanent injunction enjoining them from future violations of Section 10(b) of the Exchange Act and Rules 10b-5(a), 10b-5(b), and 10b-5(c) thereunder. They also agreed to pay a $1 million civil penalty.

Finally, today the SEC issued an administrative order against Harbinger Capital Partners, finding that the firm willfully committed three violations of Rule 105 of Regulation M under the Exchange Act. The order censures Harbinger and requires the firm to cease and desist from committing or causing any violations and any future violations of Rule 105. Harbinger agreed to pay disgorgement in the amount of $857,950, prejudgment interest in the amount of $91,838, and a civil monetary penalty in the amount of $428,975.